How to Gain From the Economy's Pain

Warren Buffett has said that a simple rule dictates his investment strategy: be fearful when others are greedy, and be greedy when others are fearful. Well, he must have cleaned up the past couple of weeks as panicky investors caused the markets to tank and rally and tank and rally again. The VIX, the volatility index—also known as the “fear gauge”—climbed 40 percent in a single trading session.

Enough with all the scrimping and saving, the austerity plans, and the slowly disappearing retirement accounts. Here’s how regular people can make like Buffett and win big in these roller-coaster times.

“Everything dropped ridiculously low as a knee-jerk response” when the S&P downgraded U.S. debt in early August, says financial adviser Ric Edelman, author of The Truth About Money. “I think everything is unfairly valued.”

He’s not alone. Plenty of the best financial advisers, money managers, hedge funders, and economists will tell you there’s opportunity hidden in the pain of economic downturns.

This is not about taking more risk than is appropriate for you. Instead, it’s a chance to do two things: First, fix your mix—in other words, rebalance your portfolio. And second, remove cash you have from the sidelines and put it to work in sync with that asset allocation.

Both those things will give you the opportunity to capture some significant bargains.

There’s just one caveat: we are talking about investing for the long term here. Money that you need in the next three to five years doesn’t belong in the stock market now—or ever. With that out of the way, here’s where the experts say to put your money to work.

The S&P 500.

“When the S&P 500 experiences a day where all 500 stocks decline, it’s a pretty clear indication that the market is oversold,” says Edelman. “So buy the S&P 500.” That’s the appropriate advice for investors who have made the decision to hold broad, diversified—and, by the way, low-cost—index funds and exchange-traded funds rather than sectors or individual stocks.

High-quality, defensive stocks.

The minutes from last week’s meeting of the Federal Open Market Committee described the economy (and its offshoots) using these words: “flattened,” “weak,” “deterioration,” and “depressed.” That was in the first five lines alone. Financial adviser Nathan Bachrach plans to make some money for his clients by amping up their ownership of high-quality, defensive stocks. Among his picks: Intel and the “oil patch,” including Chevron, Royal Dutch Shell, and ConocoPhilips, because “I don’t see us deciding to unhook ourselves from our gas-driven cars quite yet.”

Your list of dream stocks.

Maybe you’ve always wanted to own Apple? Maybe Google or Netflix? A rapid dip in across-the-board prices may be your way in. Just be sure they’ve gotten cheap enough. “I find it helpful to maintain a list of the things you want to own and the prices at which you want to own them,” says Karen Finerman, president and cofounder of Metropolitan Capital Advisors. “That takes some of the emotion out of each decision that you have to make.”

Autos.

No, I’m not suggesting you buy a car. But many other people are going to be buying them, says Mesirow Financial chief economist Diane Swonk. Not only is there a huge amount of pent-up demand for cars (we’ve been driving them for longer than ever before), but also the auto industry is one of the few that’s seen subprime financing come back. People who can’t qualify for credit cards are able to buy cars, Swonk explains. That, coupled with financial incentives on par with those before the crisis, means better prospects for the beleaguered industry.

Real estate.

Finally, assuming you believe we are going to avoid a full-blown double-dip recession, you may want to give real estate another look, particularly if you wouldn’t mind being a landlord. There’s a big opportunity in buying single-family homes and renting them out, says Swonk. “People can’t qualify for a mortgage, but they want the lifestyle, the fence, the dog in the backyard. So while you can’t go in and flip to sell, you might want to flip to rent.”